Skip to main content
Insight

To what extent are franchisors obliged to protect and enhance their brand in the face of competition?

Franchise industry commentators in North America have had a lot to talk about over the last couple of years, as the franchise model has been subjected to a number of important legal challenges in both Franchise industry commentators in North America have had a lot to talk about over the last couple of years, as the franchise model has been subjected to a number of important legal challenges in both the US and Canada. Special interest groups in the US have been lobbying state legislators to bring about changes in law which seek to address certain perceived defects or inequities in the franchise relationship, including: the Californian “Fair Franchising Act”, which seeks to give franchisees "equity" in the brand which can be realized on the expiry of franchise rights; the National Labor Relations Board ruling that McDonald’s (and therefore other franchisors) could be held jointly liable for labour and wage violations by its franchise operators; and the Seattle Minimum Wage Act, which requires companies with more than 500 employees to raise their hourly wages to $15 over the next three years and treats franchise networks as a single entity (please click here to view our blog on these developments).

A recent ruling on a case involving Dunkin' Donuts has now shifted the focus north of the border to Canada and the province of Quebec, where the Quebec Court of Appeal recently upheld the Superior Court's decision in relation to a long-running dispute between Dunkin' Brands and 21 of its franchisees who operated outlets in Quebec. The ruling should be of interest to the wider international franchise community as it raises some interesting issues regarding the fundamental principles of the franchisor relationship, and specifically the extent to which a franchisor is obliged to support and protect its franchisees.

What Happened?

In 2003, 21 Dunkin' Donuts franchisees operating in Quebec issued proceedings against their franchisor, claiming that they did not get enough support and protection from their franchisor in the face of fierce local competition from rival brand, Tim Hortons, even after franchisees had brought their concerns to the franchisor's attention and requested specific action. The franchisees' businesses suffered declining sales and they sought to terminate their franchise agreements and claims damages from their franchisor for loss of profits.

The Quebec Superior Court ruled that the franchisor had breached express and implied terms of the franchise agreements, which required the franchisor to protect and enhance the reputation of the brand and the demand for the products. The court awarded damages of approximately £8 million to the franchisees.

On appeal, the Quebec Court of Appeal upheld the first ruling but reduced the level of damages to approximately £5 million in recognition of the fact that there were other factors which contributed to the franchisees' loss of profits. The Quebec Court of Appeal agreed that the franchise agreement contained a binding contractual obligation on the franchisor to "protect and enhance" its brand. However, the court went further and also found that, in the context of a long-term commercial relationship like franchising, there was an implied obligation to protect the brand, including with respect to the impact of local competition.

The court's rationale for implying this term into the franchise agreement was that the franchisor had enticed prospective franchisees to join the network by emphasising the commercial value of its brand and system. As such, franchisees were entitled to rely on their franchisor to maintain the value of the brand by taking necessary steps to that end - this obligation applied to both internal forces (such as policing the system and taking action against underperforming franchisees) and external forces (such as competition).

Dunkin' Brands has requested an appeal before the Supreme Court of Canada, which will be either confirmed or denied later this year or early next year.

What does it mean?

The Quebec Court of Appeal considered that the principles of cooperation, collaboration, ongoing support and assistance were fundamental to the franchise relationship. Whilst franchise agreements are typically one-sided agreements which confer a high degree of power and discretion on the franchisor, it was the court's view that with such power comes responsibility. If a franchisor requires its franchisees to rigidly follow the system, the franchisor is duty bound to its compliant franchisees to take action against and "weed out" non-compliant franchisees. Equally, if the franchisor is providing a proven business format and requiring its franchisees to follow the system, a franchisor owes a duty to the network to maintain and protect the brand in the face of competitive forces.

The court's decision in respect of the implied term is consistent with a number of other civil law and common law jurisdictions (France, Germany, Australia and the US, for example), in which either the legislature has passed protectionist laws in favour of franchisees and/or the concept of good faith in franchising has been evolving in their respective case law.

What's the position under English law?

The English courts would undoubtedly respect and uphold the express terms of the contract. If the term in question is expressed as a general obligation, the scope of the obligation will be open to interpretation. If the facts fit, it is conceivable that the English Courts might adopt a similar rationale to that followed by the Quebec Court of Appeal.

However, with regard to implied terms, English law has been swimming against the tide in this respect. Since the Yam Seng case in the High Court, in which Mr Justice Leggatt argued that English law is at odds with other jurisdictions by not recognizing a general duty of good faith in long term relational contracts like franchise agreements, the English courts have repeatedly shown a determination to uphold a traditional, narrow approach to implied terms. This culminated in the recent Carewatch case, in which an implied term of good faith was considered in the context of a franchising dispute, and rejected by Mr Justice Henderson.

When considering the validity of an implied term, the recent case law suggests that the English courts will look at the express terms first and then consider if an implied term is necessary to fill a contractual "lacuna". If it is necessary, it would be implied narrowly and only if by doing so, the implied term did not contradict the express terms. Equally, whilst parties to a contract should act honestly, that does not mean that a party to a commercial contract should subordinate its own commercial interests to those of the other contracting party.

Takeaways

The Dunkin' Brands case undoubtedly raises some interesting and important issues concerning the fundamental principles of the franchise relationship. It is conceivable that the Dunkin' Donuts decision could be interpreted and applied to future franchising disputes in the UK as persuasive evidence, depending on the facts of the dispute.

Franchisors should therefore re-visit the express terms of their agreements and consider:

  • whether statements regarding the value of the goodwill and system might be construed as creating an obligation on the franchisor to protect and enhance the brand.

  • whether they have sufficient power and flexibility in their agreements and auditing processes to take effective action against underperforming franchisees - this aspect is not always explained adequately to prospective franchisees, who see a one-sided agreement and do not understand that it is structured that way for the mutual benefit of the parties. However, the quid pro quo is that a responsible franchisor should be committed to policing its network robustly and enforcing the terms of its agreements.

  • whether to include express statements which are designed to circumscribe the extent of their general duties in respect of protecting and enhancing the brand. There is a difficult balance to strike between franchisors setting realistic expectations and absolving themselves from a reasonable level of responsibility towards their franchisees.

  • the extent of their obligations to develop and implement improvements to the system.


From a general, commercial point of view, franchisors should keep a watchful eye on shifting consumer trends, what the competition is doing and consider engaging with their franchisees on innovations to the business system.

Sign up to our email digest

Click to subscribe or manage your email preferences.

SUBSCRIBE